Price Elasticity of Gold

The general inverse relationship between price and demand is a key fundamental in economics. A rise in price is known to shrink demand and vice versa. However, another important factor in economics is the price elasticity of demand, which can be interpreted as the percentage change in demand relative to the percentage change in price. Basic goods tend to be of low elasticity, thus the change in price has little effect on demand, while luxury goods are usually of high elasticity where demand varies greatly opposing a slight change in prices.

In our analysis of the worldwide demand for gold over the past 3 years, the trend shows that a decrease in price leads to a decrease in the demand for gold and vice-versa. This shows that consumers are willing to pay a higher price for gold than a lower one.

The below data and graph depicts the price-demand relation of gold over the past 3 years: Quarter – Year| Quantity demanded (in thousand tons)| Price ($US bn)| Price Elasticity | Q1 – 08| 13.4| 450| -|

Q2 – 08| 15| 521| 0.76|
Q3 – 08| 18.8| 672| 0.87|
Q4 – 08| 14| 548| 1.38|
Q1 – 09| 9.6| 329| 0.79|
Q2 – 09| 12.8| 431| 1.08|
Q3 – 09| 15.1| 490| 1.31|
Q4 – 09| 18.1| 511| 4.64|
Q1 – 10| 18.6| 521| 1.41|
Q2 – 10| 16.3| 422| 0.65|
Q3 – 10| 21.3| 541| 1.09|
Q4 – 10| 25.3| 575| 2.99|

Price Elasticity: ΔQuantity DemandedΔPrice X Initial PriceInitial Quantity

Demand curve of gold from 2008 – 2010 per quarter

Price Elasticity of gold from 2008-2010
Gold, being a luxury product wherein the price elasticity is high i.e. an increase / decrease in price leads to a high change in demand. A couple of factors affecting the high elasticity of gold are: * The snob effect: preference for goods because they are different from those commonly preferred; in other words, for consumers who want to use exclusive products, price is quality * The bandwagon effect: preference for a good increases as the number of people buying them increases; From our analysis, we arrived at two relations which affects the demand of gold, one direct and the other inverse.

The first relation is the direct relation
Dq = F (PG, P S, Pp, Income, Taste, Seasonal)
PG – Price of gold
PS – Price of silver
Pp- Price of platinum
The demand for gold is directly affected by the hike in silver and platinum. The reason being, gold is considered as the substitute for platinum. Also we found that the personal disposable income and the taste i.e. the design and quality of the gold affect the demand directly.

The second relation is the inverse relation of the investment function; Iq = F (P G, P$, PP, Instruments, Economic conditions) PG – Price of gold
P$ – Price of Dollar rate at world market
PP- Price of petrol
The increase in the price of the dollar at the world market decreases the demand for gold. Also the economic conditions, the price of petrol which is been used for the extraction and refining purposes and cost of machineries and production also affects the demand for gold indirectly. Even though price of gold has a direct relation on the demand, the other factors like P$, PP et all negates the direct relation of gold on the investment function. Another interesting trend we analyzed was the demand for gold during the second half of the year has always been high, regardless of the price. This is mainly due to the wedding and festival season in India (being having the highest consumption – approx. 40%1).

For example; Q3 and Q4 of every year from 2008-2010 shows a higher demand rate despite an increase in price than when compared to the previous two quarters. In India, the wedding season starts from October and coincidently most festivals also fall during the same period. Hence the demand for gold shot up during this time of the year. Another interesting trend that can be observed from the above table is the dramatic increase in the elasticity of gold in Q4 of 2009. Following the recession in 2008-‘09, investors and the consumers started relying more on the gold as compared to other sources of investment such as stock and shares, which in turn pushed gold prices up. This led to an increase in the demand for gold and subsequently the higher price and for the first time in three years the price elasticity for gold touched the peak of 4.64. In conclusion, gold, being a luxury good has a positive price-demand relation and has a ‘greater than unitary elastic’ demand.

References:

http://goldandsilverblog.com/gold-and-silver-etf-holdings-decline-on-week-while-europes-debt-crisis-expands-0279/ http://www.gold.org/media/press_releases/archive/2011/02/global_gold_demand_in_2010_reached_a_10_year_high_in_tonnage_and_all_time_high_in_value/ http://www1.goldtrades.info/index.php/weekly-analysis/gold-price-forecasts http://www.munknee.com/2010/06/12180/